the mcgraw-hill companies, inc. 2008mcgraw-hill/irwin chapter 13 financial statement analysis
TRANSCRIPT
The McGraw-Hill Companies, Inc. 2008McGraw-Hill/Irwin
CHAPTER 13
Financial Statement Analysis
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13-2
Learning Objective
LO1LO1
To describe factors associated with communicating
useful information
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13-3Factors in Communicating Useful Information
Users
Types of Decisions
Means of Analysis
The primary objective of accounting is to provide information useful for decision making. To provide
information that supports this objective, accountants must consider the following:
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13-4
Learning Objective
LO2LO2
To differentiate between horizontal
and vertical analysis
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Methods of Analysis
Horizontal Analysis
Vertical Analysis
Ratio Analysis
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13-6Milavec Company Financial Statements
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13-7Milavec Company Financial Statements
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13-8
Horizontal Analysis
Horizontal analysis (or trend analysis) refers to studying the behavior of
individual financial statement items over several accounting periods.
Absolute Amounts
Percentage Analysis
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13-9Milavec Company Horizontal Analysis
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13-10
Vertical Analysis
Vertical analysis Vertical analysis uses uses percentages to compare percentages to compare individual components of individual components of
financial statements to a key financial statements to a key statement figure. Astatement figure. A common- common-
sizesize financial statement is a vertical analysis in which each
financial statement item is expressed as a percentage.
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13-11
Vertical Analysis of Income Statement
In income statements, all
items are usually
expressed as a percentage of
sales.
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13-12Milavec Company Vertical Analysis
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Vertical Analysis of Balance Sheet
In balance sheets, all items
are usually expressed as a percentage of total assets.
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Learning Objective
LO3LO3
To explain ratio analysis
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Ratio Analysis
Ratio analysis involves studying
various relationships
between different items reported in a
set of financial statements.
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Learning Objective
LO4LO4
To calculate ratios for assessing a
company’s liquidity
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Liquidity Ratios
Liquidity ratios indicate a company’s ability to pay short-
term debts. They focus on current assets and current
liabilities.
1. Working Capital
2. Current Ratio
3. Quick Ratio
4. Accounts Receivable Ratios
5. Inventory Ratios
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Working CapitalThe excess of current assets
over current liabilities is known as working capital.
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Current Ratio
The current ratio measures a company’s short-term debt
paying ability.
A declining ratio may be a sign of deteriorating
financial condition, or it might result from eliminating
obsolete inventories.
CurrentRatio
Current Assets Current Liabilities
=
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Current Ratio
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Quick (Acid-Test) Ratio
Quick Assets Current Liabilities
=Acid-Test
Ratio
Quick assets include Cash,Current Marketable Securities, and
Accounts Receivable. This ratio measures a company’s ability
to meet obligations without having to liquidate inventory.
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Quick (Acid-Test) Ratio
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13-24Accounts Receivable Turnover
Net Credit Sales Average Accounts Receivable
Accounts ReceivableTurnover
=
This ratio measures how many times a company converts its
receivables into cash each year.
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13-25Accounts Receivable Turnover
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Average Days to Collect Receivables
Average Collection
Period=
365 Days Accounts Receivable Turnover
This ratio measures, on average, how many days it takes to collect
an accounts receivable.
= 21 daysAverage
Collection Period
= 365 Days 16.98 Times
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Inventory Turnover
Cost of Goods Sold Average Inventory
InventoryTurnover
=
This ratio measures how many times a company’s inventory has been
sold and replaced during the year.
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Inventory Turnover
INSERT Insert 20, p.
543, Text Box here
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Average Days to Sell Inventory
Average Sale Period
= 365 Days Inventory Turnover
This ratio measures how many days, on average, it takes to sell
the inventory.
= 34 daysAverage
Sale Period=
365 Days 10.80 Times
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Learning Objective
LO5LO5
To calculate ratios for assessing a
company’s solvency
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Solvency Ratios
Solvency ratios are used to analyze a company’s long-term debt-
paying ability and its financing structure.
1. Debt to Assets Ratio
2. Debt to Equity Ratio
3. Number of Times Interest Earned
4. Plant Assets to Long-Term Liabilities
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Debt to Assets Ratio
This ratio measures the percentage of a company’s assets that are financed by
debt.
Total Liabilities Total Assets
Debt to Assets Ratio
=
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Debt to Equity Ratio
This ratio indicates the relative proportions of debt to equity on a
company’s balance sheet.
Stockholders like a lot of debt if the company can
take advantage of positive financial
leverage.
Total Liabilities Stockholders’ Equity
Debt to Equity Ratio
=
Creditors prefer less debt and more equity
because equity represents a buffer of
protection.
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Debt to Assets and Debt to Equity Ratios
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Number of TimesInterest is Earned Ratio
This is the most common measure of a company’s ability
to provide protection for its long-term creditors.
Times Interest Earned
Earnings before Interest Expense and Income TaxesInterest Expense=
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Number of Times Interest Earned Ratio
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Plant Assets to Long-Term Liabilities
This ratio suggests how well long-term debt is managed to
finance long-term assets.
Plant Assets to Long-Term
Liabilities
Net Plant AssetsLong-Term Liabilities=
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Plant Assets to Long-Term Liabilities
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Learning Objective
LO6LO6
To calculate ratios for assessing
company management’s effectiveness
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Profitability Ratios
Profitability ratios measure a company’s ability to generate
earnings.
1. Net Margin (or Return on Sales)
2. Asset Turnover Ratio
3. Return on Investment
4. Return on Equity
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Net Margin
This measure describes the percent remaining of each sales dollar after
subtracting other expenses as well as cost of goods sold.
Net Margin
Net Income Net Sales
=
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Net Margin
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Asset Turnover Ratio
Net Sales Average Total Assets
AssetTurnover
=
This ratio measures how many sales dollars were generated
for each dollar of assets invested.
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Asset Turnover Ratio
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Return on Investment (ROI)
This is the ratio of wealth generated (net income) to the amount invested
(average total assets).
Return on
Investment
Net Income
Average Total Assets=
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Return on Investment (ROI)
* The computation of average assets is calculated as
beginning assets plus ending assets divided by 2.
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Return on Equity
This measure is often used to measure the profitability of the stockholders’
investment.
Return on Equity
Net IncomeAverage Total Stockholders’
Equity
=
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Return on Equity
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Learning Objective
LO7LO7
To calculate ratios for assessing a
company’s position in the stock market
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Stock Market Ratios
Stock market ratios analyze the earnings and dividends of a
company.
1. Earnings Per Share
2. Book Value
3. Price-Earnings (PE) Ratio
4. Dividend Yield
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Earnings Per Share
Earnings per
Share
Net Earnings Available for Common Stock Average Number of Outstanding Common
Shares
=
This measure indicates how muchincome was earned for each share of
common stock outstanding.
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Earnings Per Share
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Book Value Per Share
This ratio measures the amount that would be distributed to holders of each share of common
stock if all assets were sold at their balance sheet carrying amounts and if all creditors were paid off.
Book Value per Share
Stockholders’ Equity - Preferred Dividends Outstanding Common Shares
=
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Book Value Per Share
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Price-Earnings Ratio
Price-EarningsRatio
Market Price Per Share Earnings Per Share
=
This ratio compares the earnings of a company to the market price for a share
of the company’s stock.
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Dividend Yield
DividendYield
Dividends Per Share Market Price Per Share
=
This ratio identifies the return, in terms of cash dividends, on the current
market price of the stock.
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Learning Objective
LO8LO8
To explain the limitations of
financial statement analysis
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13-58Limitations of Financial Statement Analysis
Different Industries
Changing Economic
Environment
Accounting Principles
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End of Chapter 13